Emerging markets: Where are the opportunities today?

Martin Lefebvre

Hi everyone, I'm your host, Martin Lefebvre, CIO at National Bank Investments. Thank you for tuning into our NBI podcast series on the economy and financial markets. Today I'm joined by Maria Negrete-Gruson, Portfolio Manager at Artisan Partners, and the focus of the discussion will be on emerging markets (EMs). Maria, welcome and thank you for being with us.

Maria Negrete-Gruson

Thank you, I'm glad to be here.

Martin Lefebvre

Excellent. Maria, before we turn into your portfolio positioning and recommendations, why don't we start with some basics? Can you tell us what type of conditions are generally needed for an outperformance of emerging markets versus the rest of the world or U.S. equities more general?

Maria Negrete-Gruson

Yes, I think that has been a big question of late, given the underperformance of the asset class versus what has been a very strong U.S. market. I think the reality is, the way we look at in reality, the history of demonstrates that the dynamics in these countries, in these markets, is really what drives the growth. You can say, well, you need a weak dollar or you need lower rates. Well, in reality, those have been better environments. But really, what you need is sort of dynamism of the domestic markets and you can still have plenty of that today, even in an external environment or perhaps a global environment that is not so benign.

Martin Lefebvre

So you've mentioned it yourself, the U.S. has been outperforming for the past almost 15 years now, but there was a time where emerging markets were outperforming. I recall the industrialization of China and India when the U.S. dollar was indeed fairly cheap. So right now, EM seems to be cheap on an historical basis, whether you look at the price -earnings ratio, relative to the U.S., do you feel that we're on the verge of a reversal of that U.S. outperformance?

Maria Negrete-Gruson

From our point of view, and we are dedicated managers, so our job is to really to find the opportunity. And we do find plenty of that in emerging markets today. I think a bit of the issue of the past is almost definitional. The part of kind of trying to simplify emerging markets to be the BRICS or just a handful of countries, when in reality the opportunity in goes most beyond that. It's almost outside of that BRICS space is where the opportunity lies. And there are those dynamics that you mentioned industrialization, low penetration. Those are very much alive and well. And that is the type of opportunity that we think exists today at a, as you say, very discounted valuation.

Martin Lefebvre

You mentioned, you just mentioned BRICS. And I remember when I was more active in portfolio management, it seemed that emerging market was only seen as one block. And whenever there were, you know, either China was going well or India was doing well, there were strong inflows. But on the contrary, if there was something in Turkey or a crisis in Brazil, then there were strong outflows. As things changed at all in that sense, what are the strong drivers nowadays?

Maria Negrete-Gruson

I think that external driver still remains the portfolio investment that is certainly part of the dynamics, but the markets have matured to some degree that the domestic dynamics are also very important. And that is what I say, you have to kind of identify the perhaps looking marginal market, but that has very much these domestic dynamics going very well, the consumer, the middle-class creation, all these things that happen almost parallel to what's happening in the external world. So I think that is when I say the simplification that is just a handful of countries, there is just about the large population or the ones who attract the capital. No, it's the other stuff also matters. And I think that is what creates a more diverse and more sustainable type of opportunity in emerging markets.

Martin Lefebvre

What about volatility? It seems that every bit of news that we get from the emerging markets kind of creates uncertainty on the market. We certainly saw over the past couple of weeks the election results in India and Mexico that seem to have created a lot of volatility. Can you tell us why it's still the case and more specifically perhaps on the governance when it comes to emerging markets?

Maria Negrete-Gruson

Volatility to us means opportunity. This is where we get the opportunity to get a market, a stock that we really like, that we have been watching and we have sort of liked, but we don't have enough upside. These moments of sort of this election kind of panic, all that creates the opportunity. And I think that is something that is inherent to the asset class, high volatility, the fragility, that we shouldn't, should not expect that. That is part of what it is. EMs will continue to be that, but then that creates when you have more of a longer-term mindset and more long-term commitment to the asset class, you can take these moments as an opportunity to enter the market. So in terms of, I think I will say a separate part of the question in governance, I think that is critical and that is critical to our process. Our process mindset has always been, and process is very long, we have been doing this for several decades and governance has been at the center of that. We believe it's not the behaviour of the market or even the government or the country where you're operating is the behaviour of the company within that market. How the company knows how to navigate, how the company understands themselves and their responsibility to us as minority shareholders, that is critical to navigate these inevitably turbulent waters that are going to be emerging markets.

Martin Lefebvre

What about China? China was almost, I don't recall the exact number, but let's call it 50% of emerging markets not so long ago. And it seemed that it's a little lower now. Do you find that the government is doing enough to kickstart the economy? And what about all the risks surrounding the housing market? How do you view China nowadays?

Maria Negrete-Gruson

For us, China has always, relative to this sort of benchmark idea of what China is, we have always maintained a more structural, smaller position. We find that within this trying to create a, like replicate an index with China being a big part of it, it's never been our aim. So within that sort of smaller universe that is China to us, why is that a smaller universe? Because a lot of the parts of China get sort of disqualified in our process for the basics of, I don't know, a lot of the state-owned companies that do not operate as a company. It's more a ministry of state, so those are not compelling to us. And on the other parts, in the basic governance of these companies, what it is to be a public company, a lot of companies get disqualified there. Then the opportunity is smaller, but within that opportunity, we do find companies we can invest there. I think what has happened, the question is the government doing enough. I think we don't like to rely on that government stimulus as being what drives the market. I think we have to find companies in China that can take advantage of this environment that we have today. And this environment today is one that is more focused externally. The domestic market is weak. The government has been sort of slow at sort of injecting kind of energy to that market. But there's still the exportation-oriented part that is a big part of the market. We need to find companies that play that well, that have that capacity. So it is perhaps the opportunity smaller than when it appears when you look at the huge sort of range of what China is. But even within that, we think that there are opportunities, paying attention, big attention to issues like governance.

Martin Lefebvre

You mentioned you were slightly underweight China most of the time. What type of approach do you favour? Are you more of a sector approach or a geographic approach? What's your current position?

Maria Negrete-Gruson

Our approach is bottom-up stock selection. So that's what drives our process. So whatever happens at the sector allocation is consequence of the stock selection. On the country, though, we do have a country risk assessment that is very specific to each country. We look at several factors. And that sort of penalizes our target evaluation. So it's not about a beauty contest, as I say. It's not trying to rank all the countries from good to bad and say, well, I'm going to go invest in the good ones and avoid the bad ones. It's more about how does it impact to our company being in this country? Do I need to penalize it? How much do I need to penalize my valuation? And that is what creates the outcome, right? So it's ultimately at the stock level and the country risk is something that is of a penalization, almost a risk mitigation rather than a country allocation. So our process inherently is all coming up from the bottom up, our construction of the portfolio.

Martin Lefebvre

Okay, but it's just a result of your bottom-up approach. You're not trying to be market neutral or geographic neutral at all. Okay, I understand. We talked a little bit about governance, but what about the rest of ESG? Do you incorporate this analysis in your work?

Maria Negrete-Gruson

Yes, we believe sustainability and ESG is integral to the opportunity in emerging markets. As I say, ESG is not an adornment that we put on our stocks. It's critical to these companies being able to do what they do. So our process is looking at the earning power of the company, looking at the country risk, and looking at the ESG assessments. All equally important to determine the opportunity. When we're looking at unique access to growth or a sustainable competitive advantage, which is what attracts us to a stock, these sustainable competitive advantages to be truly sustainable, right? If your advantage is to abuse the environment, to like, let's abuse your employees, well, that is not sustainable in our mind. So we really need to find truly sustainable opportunities to create what is the upside that we're looking for in our stocks.

Martin Lefebvre

I understand. Perhaps I'm going to ask you a last question on countries. India has been a superstar of late and, post-COVID, Latin America did also fairly well. Do you have a favourite region to invest in nowadays?

Maria Negrete-Gruson

It’s about the stocks with us, but the outcome of that has been more inclined towards that time of late. India, as much as we do like the dynamics in India in terms of growth and penetration, a lot of qualities, we do, we haven't found sort of as many opportunities and in the past, I think a lot of the euphoria that India has sort of built around, especially a lot of the capital that has exited China for geopolitical reasons and other reasons are moving to India. And sort of that has created perhaps a less compelling story. So we believe in their story, we continue to pursue it, and we welcome opportunities of correction, like what has happened post -election to kind of take a deeper look at that market and more opportunities there. On that time, very important to highlight our overweight is not very stock country specific. We are very diverse in our exposure. And that is something that is not Brazil-centric as typically Latins tends to be. We look at opportunities in other regions, in other parts, and we are in Argentina, we are in Panama, we are in many parts that you can say are like the fringe parts of Latin America. But in our mind, those are the true expressions of what these stories that we're trying to look for are in Latin America.

Martin Lefebvre

Okay, I don't want to ask you another question. You said you were bottom up and stock pickers. So how many stocks or companies compose your universe and how you filter down and come up with a certain number of companies that you're comfortable with?

Maria Negrete-Gruson

Given our vast experience, what we call our library, which is companies that we have done full engagement. We engage a lot with the companies. We travel extensively, 800 meetings last year. It's a big part of what we do, just travel. I just came back from Jakarta. That's part of what we do. So that library is very long. So it's 700 names that we have really have full kind of analysis over the years. But the analysts, I would say, they have about 10 stocks in the portfolio and about 25 names in the kind of hard list that we have ready to act on. That is sort of the more limited library of names that have been currently updated. And that is where we grow. The analysts do four new analysis per quarter. And that is at the pace that our library grows. These are the four names we're analyzing. So it's a very slow moving process in a way. But given that has been done for such a long time, it creates a very large library of which stocks that we have are normalized earnings, our ESG assessment, and our target valuation.

Martin Lefebvre

Well, Maria Negrete, thank you very much for enlightening us on emerging markets and for everyone listening to this podcast. Thank you very much for tuning in to, and we'll talk again next month.

Maria Negrete-Gruson

Thank you.